Monday, November 26, 2007

Barriers to Entry

To determine whether a company has a business moat ie whether it can defend its turf when competitors come in, we look at what is called Barriers to Entry, one of Porter's 5 Forces. I have identified a few common barriers but I must point out that the list is not exhaustive. Other barriers exist and it takes experience and knowledge to identify them. Again, investing is about life-long learning and hard-work. It is not about get-rich-quick.

Market share
This is the most basic edge a company can have over its competitors. When a company is the No.1 or No.2 in its field, it is simply much more difficult for the laggards or any newcomers to try enter their market. Esp if there are only 2 or 3 big players in the market. This is bcos standards are set and relationships have already been established, and the laggards and newcomers don't have the resources or time to beat the leaders.

Technological edge
This edge can be manifested in several ways. It can be simply authentic technological capabilities, like Toyota with its hybrid technology which it was the first to developed and remain the leader today. Or it can be superior manufacturing technology which allows the company to make stuff cheaper yet have similar or better quality. Like Samsung's LCD TVs.

High initial investment cost
Some businesses require very high start-up cost and this naturally deters competition. Oil/mineral exploration, wafer fabs, a telco network etc. It is simply not business that any Tom, Dick, Harry can start. Sometimes, it can only be started by the government. So when a business can earn a good return and its in one of these high start-up cost sectors, hmm, maybe it can be interesting.

This is one of the best barriers a company can ever build. Buffett prides his See's Candy, commenting how people will always buy See's Candy even when it keep raising prices. Great brands like Coca Cola, Louis Vuitton, Rolex and our beloved Ipod are simply immune to competition. No matter what the competitors do, people will still buy Coke to drink, LV bags, Rolex watches and the Ipod over Creative Mp3 players.

This is the most tricky barrier. Sometimes it works very well for the company in question, but sometimes it simply screw things up. The investor has to become a political analyst to get this one right. Eg. oil fields in Indonesia and Russia. Although major co.s like Shell etc negotiated for rights to sell the oil in these fields some years ago with the respective govts, the contracts were void since oil prices shot through the roof. In the case of Russia, the rights were forced to be sold back to Russian co.s. Suck thumb right? Some value investors stay away from highly regulated sectors altogether.

So, as mentioned, there are other barriers and it takes time and experience to identify them. But when you know the company has got a good business moat, earns a good return, and reward shareholders, then go for it. In Singapore, some co.s that comes to mind would be your mass transport stocks, newspaper, telcos etc.


  1. Hi 8percentpa,

    Thanks for blogging about sustainable competitive advantage ! You summarized and categorized it very well indeed. It is heartening to know that there are other value investors in Singapore like yourself who blog regularly about the importance of intelligent investing (i.e. value investing). Keep up the great work !

    Regards, Musicwhiz

  2. Hi 8%pa,

    First time commenting here :)

    How about another competitive advantage - that of high switching cost? The cost I'm talking about here need not be monetary, but more in terms of time spent.

    Some examples to illustrate:

    1. The main reason I do not want to switch to another telco is because of the loss of my number (and the hassle of contacting everyone again to inform them of your new no.), rather than the cost. With the coming true number retention system, there will be a shift in the market share between the 3 telco.

    2. Microsoft words isn't fantastic and isn't cheap. But the fact that so many people are using it is because there are so many other people using it. If you don't use it, the cost of switching might be too high to warrant it in the first place. Same thing for individual users - once someone is trained in a software, the cost of spending time again to re-learn another software is too high.

  3. Hi Musicwhiz, thanks for the compliment, I like your blog too, have added a link to it!

    Hi la papillion, thanks for the additions, yes I totally agree with you. As I mentioned, the list is not exhaustive, to all readers, contribute some if you can!